Articles

Corporate Finance: Financing Real Assets in Challenging Markets

By Donghyun Lee

Published: 8/10/2018

Investing in real assets in frontier markets can be challenging. Here are five tips to consider to help you finance real assets effectively.

Real assets can be defined as physical assets or properties with value. They include real estate, infrastructure, and commodities, and tend to be illiquid and long-term as well as typically part of a diversified development and investment portfolio.

In developed and some developing countries, real assets have been connected with more of a strategic, short-term financial perspective in mind because there are so many mature and diversified market participants. On the other hand, investing in real assets in frontier markets is more difficult because there are serious needs for real assets to fulfill at least minimum and adequate economic requirements. These real assets often have low credit ratings, insufficient market size, and even insufficient business and financial data to initiate financing. So, normal analytical tools and financing approach are not a good fit.

5 TIPS WHEN FINANCING REAL ASSETS IN DIFFICULT MARKETS

Here are five tips to consider when financing real assets effectively in difficult markets.

These markets generally have capital shortage and low-stage, private-sector development, so there is a high level of dependency on public sector financing. So, adequate participation of public sector financing is important to secure business and financial stability for better credit and funding.

Using tailored sovereign guarantees to entice public financing should be included. Examples include: a minimum revenue guarantee or cost compensation; a natural resources guarantee; concession extensions; revenue enhancements; put and call option agreements; purchase agreement; a sovereign guarantee including debt assumption undertakings; and other financial and regulatory hedges such as termination or residual value payments or a clause for change of law.

Consider working with multilateral development financial institutions. These organizations have experience in difficult markets and working with private finance. They can offer various financing vehicles, guarantees, insurance, quasi-balance with local public entities and risk-taking if real assets are under their requirements like development, economic and financial conditions to support financing. Participation of multilateral development financial institutions will entice other private financial institutions to invest and improve the quality of the borrowing pool.

Insurance and incentives also can facilitate better financing. Insurance can be used in property insurance deals to protect real assets as collateral, and as credit enhancements to lower financing costs and attain appropriate risk hedging. These vary by local insurance and re-insurance laws and policies. Various incentives from central and local public sectors also can contribute to better profitability based on a risk-return matrix. These can be financial and non-financial assistance, including grants, subsidies, tax exemptions, support for currency and rate changes, and regulatory support to influence the financing.

It is critical to understand local real estate regulations when investing in this type of real asset. Some countries restrict land ownership, while others have detailed rules about land rights, status of land, and appraisal value. All of these can effect pricing and feasibility.

External financing conditions must be reviewed as well. You may be forced to make uneven payments, so creating a contingency reserve is an option when initially structuring the deal. You may not want to emphasize currency and rate terms too much because the local currency and rates market may be fairly illiquid. Other financing considerations, such as governing laws, arbitration clauses, taxation, and money remittances, also affect real assets financing.

Many companies are really hesitant to consider the real assets development and financing in difficult markets because of risk. But smaller participants can finance real assets in difficult markets, although seeking additional alpha can be expected.